Optimal Inventory Turnover Ratio

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Jaap de Jonge
Editor, Netherlands

Optimal Days Inventory Outstanding

A low turnover rate may indicate overstocking, obsolescence, or deficiencies in the product line or marketing effort.
The purpose of increasing inventory turns is to reduce inventory for several reasons:

Increasing inventory turns reduces holding cost. The firm will have to spend less money on rent, utilities, insurance, theft and other costs of maintaining inventory of the goods to be sold.
Reducing holding cost will make the firm's net income and profitability increase (as long as the revenue from selling the item remains constant!)
Inventory that turns over more quickly increases the responsiveness to changes in customer requirements and decreases the need for replacement of obsolete items.

However, in some instances a low turnover rate (and a longer Days Inventory Outstanding) may be appropriate, such as where higher inventory levels occur in anticipation of rapidly rising prices, expected market shortages, or in general where keeping more stock will result in higher sales volumes.

Note that when you're making comparison between firms, it's important to take note of the industry, or the comparison will be distorted. Making comparison between a supermarket and a car dealer, is normally not appropriate, as supermarket sells fast-moving goods like fruits and soft drinks, so their stock turnover will be higher. A car dealer on the other hand will have a much lower turnover, due to the item being slow-moving. An intra-industry comparison will be more appropriate.